As we enter our 12th week of lockdown, the FCA has begun a process to obtain regular, specific data from a substantial number of firms to better predict the vulnerability of financial services firms, and thereby the impact on consumers. E-money issuers, payment service providers, CFD providers, advisers and intermediaries are among the targeted sectors and emails advising those selected for the first batch have already arrived with our clients. In this blog I will explain what the FCA is looking for and what you should be doing.
As in this blog on capital stress testing at the beginning of lockdown, financial resilience and client money were always going to be a focal point for FCA supervision.
For payment and e-money institutions, the FCA launched a consultation on temporary guidance on safeguarding and prudential risk management in light of the pandemic crisis a fortnight ago. Responses were due on Friday past but the exceptionally short consultation period has been extended by a week. We expect the finalised guidance to be brought into play equally quickly.
Well, this week the FCA’s attention has turned to financial resilience with the launch of a “Financial Resilience Survey”. The regulator plans to survey 13,000 solo regulated firms to understand the impact of Covid-19 on both regulated firms and consumers. The first surveys were issued on Thursday, with another batch scheduled for issue today. Response to the survey is mandatory, and firms will have seven working days to either complete the survey or explain why they cannot meet the deadline.
The FCA has clarified that the survey should be completed using the latest financial information (even if firms expect some variances to the final audited financial statements) and that it should not take more than an hour to complete.
The survey consists of ten questions, broken down into four sections.
- Financial performance/profit & loss over the last three months
- Safeguarding/client money
- Access to Government support, including loans and furlough schemes.
All firms fall under Principle 4 of the Principles for Businesses which states that “a firm must maintain adequate financial resources”.
The FCA require that both IFPRU and BIPRU firms have sufficient liquidity to ensure that they can meet their liabilities as they fall due.
Part 6 of the Capital Requirements Regulation (CRR) lays down specific liquidity requirements for investment firms. For example, Article 412 requires firms to have sufficient liquidity to cover net cash outflows under stressed conditions for a period of 30 days.
While payment and e-money institutions are not bound by a specific liquidity requirement, Principle 4 goes beyond a need to maintain adequate capital resources and implies that all firms must have sufficient liquidity to meet their obligations as they fall due.
Firms should therefore have in place detailed cash flow forecasts. These forecasts should factor in the changed business environment the pandemic has ushered in, for example taking into account any increased unreliability of debtors.
In the survey, the FCA asks questions regarding:
- the firm’s liquidity resources;
- the firm’s cash needs; and
- details of any extensions and negotiations with creditors.
The FCA also wants to know how the firm’s revenue has held up over the last three months.
Firms should already have revised their financial forecasts and stress scenarios to account for the pandemic. Capital adequacy should be regularly monitored, and firms should have detailed winddown plans.
In the recent consultation on safeguarding for payment and e-money institutions, the FCA tacked on a few proposals on capital adequacy, one of which lays out the following five steps for firms’ winddown planning.
- Funding to cover the solvent winddown of the firm, including the return of all customer funds.
- Realistic triggers to start a solvent winddown.
- The need for any counterparties (i.e. merchants) to find alternative providers.
- Realistic triggers to seek advice on entering an insolvency process.
- Information which would help an administrator or liquidator to quickly identify customer funds and return them as a priority.
Firms are often too busy focused on making their business successful to think about its potential demise, however the FCA wants to avoid cliff edge scenarios which cause detriment to consumers. If firms do fail, as they will, it should be in an orderly fashion.
Payment and e-money institutions should also bear in mind that under the FCA’s consultation, assets representing intra-group receivables should be deducted from own funds. This proposal would impact firms who rely on amounts owed by other group entities to meet their capital requirement. The FCA emphasises that there should be adequate capital within the regulated entity, rather than reliance on intragroup receivables that may not be paid in the event of financial stress.
While the consultation proposes making this a matter of “best practice”, it will be nonetheless interesting to see how the FCA will respond to payment and e-money institutions including intragroup receivables as capital in their FIN060/FSA056 returns, and we recommend that where this is done, the firm’s board should document their rationale
The survey asks questions on the following areas relating to financial performance.
- Expectations around decreases in firm income.
- Firm profit levels.
- The expected impact of Covid-19.
Protecting client money is vital during the best of economic conditions, but more so in stressed conditions where the temptation to use client money for the business’s own ends is at its greatest. The FCA therefore asks in the survey what level of client money firms are holding.
Speaking with clients over the last number of months, it is clear that some have been significantly more impacted than others. This is demonstrated in particular by the use of the furlough scheme.
Understandably, the use of government support is a good metric of the financial health of a firm, and so the FCA want detail concerning use of both the furlough scheme and government loans.
Furthermore, given the government’s announcement about the phased withdrawal of the furlough scheme over the coming months, the FCA is likely to be interested going forward in the HR plans of firms in the coming months.
Perhaps the only surprise about this survey is that it is only being launched now, almost three months into the pandemic. (Although a number of firms have already received questions from the FCA on capital and client money, and some insurance firms received an earlier survey.)
The FCA’s business plan is strong on their intention to use data and advanced analytics to become a more responsive regulator. A welcome addition to their capacity is the “rapid response team” in Payments Supervision, enabling a quick regulatory response to prudential risk management. This team is viewed as a pilot, although may also be rolled out to other regulated sectors later. Firms should therefore expect a continued focus on capital and client money in the months to come.
This post contains a general summary of advice and is not a complete or definitive statement of the law. Specific advice should be obtained where appropriate.